| Sale of
Principal Residence You may avoid tax on gain on the sale of a
principal residence if you owned and used it for at least two years during
the five-year period ending on the date of sale. If you are single, you may
avoid tax on up to $250,000 of gain, $500,000 if you are married and file
jointly. However, gain attributable to nonqualified use after 2008 is not
excludable.
If you used the residence for less than two years, you may avoid tax if you
sold because of a change of job location, poor health or unforeseen
circumstance.
You may not deduct a loss on the sale of a personal residence. Losses on the
sale of property devoted to personal use are nondeductible. However,
there are circumstances under which you may claim a loss deduction on the
sale of a residence.
If you rent out a residential property and you or family members also use
the residence during the year, rental expenses are subject to special
restrictions.
Avoiding Tax on Sale of Principal Residence
If you sell (or exchange) your principal residence at a gain, up to
$250,000 of the gain may be excluded from income if you owned and occupied
it as a principal residence for an aggregate of at least two years in the
five-year period ending on the date of sale and did not claim an exclusion
on another sale within the prior two years. See the discussion of the
two-out-of-five-year ownership and use tests in the following section. If you are married filing jointly, you may be able to exclude up to
$500,000 of gain. Even if you do not meet the two-out-of-five-year
ownership and use tests, you are entitled to a reduced maximum exclusion
limit if the primary reason for your sale was a change in the place of
employment, health reasons, or unforeseen circumstances.
Filing Instruction
Reporting Home Sale Gain or Loss on Your Return
If you have a gain on the sale of your principal residence and the entire
gain is excludable from income under the rules discussed in this topic, you
do not have to report the sale at all on your return unless you received a
Form 1099-S from the settlement agent reporting the sale. If you have a
taxable gain and did not receive Form 1099-S, or you received Form 1099-S
and have any gain that cannot be excluded, or you decide not to claim the
exclusion for excludable gain, report the transaction on Form 8949. If you
can exclude all or part of your gain, you claim the allowable exclusion by
entering code “H” in column (f) of Form 8949 and entering the exclusion as a
negative adjustment in column (g).
If you have gain that cannot be excluded,the taxable gain is subject to the
3.8% Net Investment Income Tax (NIIT), provided your income exceeds the
applicable threshold for the NIIT.
If you had a loss on the sale of your home, the loss is not deductible, but
if you received a Form 1099-S, you must report the sale on Form 8949.
Caution: If you use a residence as a vacation home or rental property after
2008, an allocable part of your gain may not qualify for the exclusion, even
if you meet the two-out-of-five-year ownership and use tests.
Frequency of exclusion. If you meet the ownership and use tests for a
principal residence, you may claim the exclusion when you sell it
although you previously claimed the exclusion for another residence,
provided that the sales are more than two years apart. If you claim the
exclusion on a sale and within two years of the first sale you sell another
principal residence, an exclusion may not be claimed on the second sale even
if you meet the ownership and use tests for that residence. There is an
exception if the second sale was due to a change in employment, health
reasons, or unforeseen circumstances. In that case, a prorated exclusion
limit is allowed.
Planning Reminder
Form 1099-S
The settlement agent responsible for closing the sale of your principal
residence must report the sale to the IRS on Form 1099-S if the sales price
exceeded $250,000, or $500,000 if you are married filing jointly. If the
price was $250,000/$500,000 or less and you provide a written, signed
certification that the full amount of your gain qualifies for the exclusion,
the settlement agent may rely on the certification and not file the Form
1099-S or may choose to file the form anyway. IRS Revenue Procedure 2007-12
has a sample certification form, but certain required assurances that are
not included in Revenue Procedure 2007-12 must be added to your
certification; see the Form 1099-S instructions .
Principal residence. A principal residence is not restricted to
one-family houses but includes a mobile home, trailer, houseboat, and
condominium apartment used as a principal residence. An investment in a
retirement community does not qualify as a principal residence unless you
receive equity in the property. In the case of a tenant-stockholder of a
cooperative housing corporation, the residence ownership requirement applies
to the ownership of the stock and the use requirement applies to the house
or apartment that the stockholder occupies.
If you have multiple homes. If you have more than one home, you may exclude
gain only on the sale of your principal residence and only if you meet the
ownership and use tests for that residence. Your “principal
residence” is determined on a year-to-year basis, based primarily on where
you live most of the time. However, the IRS may also consider such factors
as the primary residence of your family members, your place of employment,
mailing address, the address listed on your tax returns, driver’s license
and automobile and voter registration, and the location of your bank.
Vacant land. Vacant land owned and used as part of a taxpayer’s principal
residence may qualify for the exclusion. The vacant land must be adjacent to
the residence and the sale of the residence must be within two years before
or after the sale of the land. Qualifying sales of land and residence are
treated as one sale, so the $250,000 exclusion limit ($500,000 for
qualifying joint filers) applies to the combined sales. If the sales occur
in different years, the exclusion limit applies first to the residence sale.
Business or rental use. If part of your home was rented out or used for
business, see the rules for determining whether you can exclude all or some
of the gain on a sale. Also see the rules for deducting a loss where
your residence was converted to rental property.
Home destroyed or condemned. If your home is destroyed or condemned, this is
treated as a sale, so any gain realized on the conversion may qualify for
the exclusion. If vacant land used as part of your home is sold within two
years of the conversion, the sale of the land may be combined with the sale
of the residence for exclusion purposes.
Any part of the gain that may not be excluded (because it exceeds the limit)
may be postponed under the rules.
Sale of remainder interest. You may choose to exclude gain from the sale of
a remainder interest in your home. If you do, you may not choose to exclude
gain from your sale of any other interest in the home that you sell
separately. Also, you may not exclude gain from the sale of a remainder
interest to a related party. Related parties include your brothers and
sisters, half-brothers and half-sisters, spouse, ancestors (parents,
grandparents, etc.), and lineal descendents (children, grandchildren, etc.).
Related parties also include certain corporations, partnerships, trusts, and
exempt organizations.
Expatriates. You cannot claim the home sale exclusion if the expatriation
tax applies to you. The expatriation tax applies to U.S. citizens who
have renounced their citizenship (and long-term residents who have ended
their residency) if one of their principal purposes was to avoid U.S. taxes.
The exclusion is not mandatory. You do not have to apply the exclusion to a
particular qualifying sale. For example, you are unable to sell a residence
when you acquire a new residence. When you finally are able to find a buyer
for the first home, you also decide to sell the second residence. Assume
both sales may qualify for the exclusion, but the potential gain on the
first house will be less than the potential gain on the sale of the second
home. You will not want to apply the exclusion to the sale of the first home
if doing so will prevent you from applying the exclusion to the second sale
because of the rule allowing an exclusion for only one sale every two years.
Federal subsidy recapture. If your home was financed with the proceeds of a
tax-exempt bond or a qualified mortgage credit certificate and you
sell or dispose of the home within nine years of the financing, you may have
to recapture the federal subsidy received even if the sale qualifies for the
home sale exclusion. Use Form 8828 to figure the amount of the recapture
tax, which is reported on Form 1040 as a separate tax.
Meeting the Ownership and Use Tests for Exclusion
To qualify for the up-to-$250,000 exclusion, you must have owned and
occupied a home as your principal residence for at least two years during
the five-year period ending on the date of sale. The periods of ownership
and use do not have to be continuous. The ownership and use tests may be met
in different two-year periods, provided both tests are met during the
five-year period ending on the date of sale (as in Example 3 below). You
qualify if you can show that you owned the home and lived in it as your
principal residence for 24 full months or for 730 days (365 × 2) during the
five-year period ending on the date of sale. However, even you meet the
two-out-of-five-year ownership and use tests, some of your gain will be
taxable if you use the residence after 2008 as a second home or rental
property, unless an exception applies; see the discussion of the
nonqualified use rule at the end of this section.
If you or your spouse serve on qualified official extended duty as a member
of the uniformed services, Foreign Service of the United States,
intelligence community, or Peace Corps, you can suspend the five-year test
period for the years of qualified service.
Filing Tip
Short Absences
Short temporary absences for vacations count as time you used the residence.
If you are a joint owner of the residence and file a separate return, the
up-to-$250,000 exclusions applies to your share of the gain, assuming you
meet the ownership and use tests.
If you are married and file a joint return, you may claim an exclusion of up
to $500,000 if one of you meets the ownership test and both of you meet the
use test.
If the ownership and use tests are not met but the primary reason for the
sale was a change in the place of employment, health reasons, or unforeseen
circumstances, an exclusion is allowed under the reduced maximum exclusion
rules.
Even if the ownership and use tests are met, the exclusion is not allowed
for a sale if within the two-year period ending on the date of sale, you
sold another principal residence for which you claimed the exclusion.
However, a reduced exclusion limit may be available.
Court Decision
Use Test Must be Met for Newly Built Home Replacing Demolished Home
If a new house is built on the site of a former residence, the period of use
of the old house does not count towards meeting the two-year use test for
the new house. A couple wanted to remodel their home but, because of
building code and permit restrictions, decided to demolish the old house and
build a new one on the site. Once the new house was completed, they sold it
for $1.1 million, which resulted in a $600,000 gain. On their joint return,
they excluded $500,000 of the gain from their income. They had lived in the
demolished home for a number of years but never lived in the newly
constructed home.
The Tax Court agreed with the IRS that they did not qualify for the
exclusion. The exclusion applies only if the dwelling sold was actually used
by the taxpayer as a principal residence for the required two-out-of-five
years before the sale. In this case, while the demolished home was used as a
principal residence for the requisite period, the newly built home was not.
EXAMPLES
1.
From 2002 through August 2016, Janet lived with her parents in a house that
her parents owned. In September 2016, she bought this house from her
parents. She continued to live there until December 18, 2017, when she sold
it at a gain. Although Janet lived in the home for more than two years, she
did not own it for at least two years. She may not exclude any part of her
gain on the sale, unless she sold because of a change in her place of
employment, health reasons, or unforeseen circumstances.
2. John bought and moved into a house on July 9, 2015. He lived in it as his
principal residence continuously until October 1, 2016, when he went abroad
for a one-year sabbatical leave. After returning from the leave, he sold the
house on November 6, 2017. He does not meet the two-year use test. Because
his sabbatical was not a short, temporary absence, he may not include the
period of leave in his period of use in order to meet the two-year use test.
He may avoid tax on gain if he sold because of a changed job location
unforeseen circumstances, or poor health.
3.
Since 1991, Jonah lived in an apartment building that was changed to a
condominium. He bought the apartment on December 3, 2013. In February 2015,
he became ill and on April 16, 2015, he moved into his son’s home. On July
14, 2017, while still living with his son, he sold the apartment.
He may exclude gain on the sale of the apartment because he met the
ownership and use tests. The five-year period is from July 15, 2012, to July
14, 2017, the date of the sale of the apartment. He owned the apartment from
December 3, 2013, to July 14, 2017 (over two years). He lived in the
apartment from July 15, 2012 (the beginning of the five-year period) to
April 16, 2015, a period of use of over two years.
4.
In 2005, Carol bought a house and lived in it until January 31, 2014, when
she moved and put it up for rent. The house was rented from March 1, 2014,
until May 31, 2017. Carol moved back into the house on June 1, 2017, and
lived there until she sold it on September 30, 2017. During the five-year
period ending on the date of the sale (October 1, 2012 – September 30,
2017), Carol lived in the house for less than two years.
|
Five-year period -- |
Home use (months) -- |
Rental use (months)
-- |
| 10/1/12 - 1/31/14 |
16 |
|
| 3/1/14 - 5/31/17 |
|
39 |
| 6/1/17 - 9/30/17 |
4 |
-- |
| Total |
20 |
39 |
Carol may not exclude any of the gain on the sale, unless she sold the house
for health or employment reasons or due to unforeseen circumstances.
Military and Foreign Service personnel, intelligence officers, and Peace
Corps workers can suspend five-year period. You may elect to suspend the
running of the five-year ownership and use period while you or your spouse
is on qualified official extended duty as a member of the uniformed services
or Foreign Service of the United States. The suspension can be for up to 10
years. It is allowed for only one residence at a time. By making the
election and disregarding up to 10 years of qualifying service, you can
claim an exclusion where the two-year use test is met before you began the
qualifying service and after your return; see the Example below. Qualified
official extended duty means active duty for over 90 days or for an
indefinite period with a branch of the U.S. Armed Forces at a duty station
at least 50 miles from your principal residence or in Government-mandated
quarters. Members of the Foreign Service, commissioned corps of the National
Oceanic and Atmospheric Administration, and commissioned corps of the Public
Health Service who meet the active duty tests also qualify.
Caution
Residence Acquired in Like-Kind Exchange
A residence acquired in a like-kind exchange must be owned for at least five
years before gain on its sale can qualify for the exclusion.
Court Decision
Co-Owner Can Claim Full $250,000 Exclusion
A single taxpayer who sells her home at a gain after owning and using it for
at least two of the five years preceding the date of sale can exclude up to
$250,000 of gain from income. What if there are two co-owners: do they have
to split the $250,000 exclusion? Yes, argued the IRS in a 2010 case, the
$250,000 exclusion has to be shared, but the Tax Court allowed a full
exclusion. The taxpayer owned a 50% interest in a home she used as her
principal residence since February 1997. When the home was sold in 2005, her
share of the gain was $264,644.50 (half of the $529,289 total gain). She
excluded $250,000 of her gain on her 2005 return, but the IRS said she was
only entitled to half of the full exclusion, or $125,000.
The Tax Court allowed the full $250,000 exclusion. The statute (Code Section
121) does not limit the exclusion for partial owners of a principal
residence. In fact, an example in the IRS regulations specifically allows
unmarried joint owners holding 50% interests in a home to each exclude up to
the full $250,000 limit for their shares of the gain on a sale so long as
they each meet the ownership and use tests and have not excluded gain from
another home sale within the prior two-year period.
Similarly, the five-year testing period is suspended for up to 10 years for
intelligence community employees (specified national agencies and
departments) and Peace Corps workers. The suspension rule for Peace Corps
workers applies to Peace Corps employees, enrolled volunteers, or volunteer
leaders for periods during which they are on qualified official extended
duty outside the United States.
EXAMPLE
Michael bought a home in Maryland in March 2004 that he lived in before
moving to Brazil in November 2008 as a member of the Foreign Service of the
United States. He served there on qualified official extended duty for eight
years, until the end of 2016. In January 2017, he sells the Maryland home at
a gain. He did not use the home as his principal residence for two out of
the five years preceding the sale and so does not qualify for an exclusion
under the regular rule. However, Michael can exclude gain of up to $250,000
by electing to suspend the running of the five-year test period while he was
abroad with the Foreign Service. Under the election, his eight years of
service are disregarded and his years of use from March 2004—November 2008
are considered to be within the five-year period preceding the sale. He thus
meets the two-out-of-five-year test and can claim the exclusion.
Cooperative apartments. If you sell your stock in a cooperative housing
corporation, you meet the ownership and use tests if, during the five-year
period ending on the date of sale, you:
1.
Owned stock for at least two years, and
2.
Used the house or apartment that the stock entitles you to occupy as your
principal residence for at least two years.
Incapacitated homeowner. A homeowner who becomes physically or mentally
incapable of self-care is deemed to use a residence as a principal residence
during the time in which the individual owns the residence and resides in a
licensed care facility. For this rule to apply, the homeowner must have
owned and used the residence as a principal residence for an aggregate
period of at least one year during the five years preceding the sale.
If you meet this disability exception, you still have to meet the
two-out-of-five-year ownership test to claim the exclusion.
Previous home destroyed or condemned. For the ownership and use
tests, you may add time you owned and lived in a previous home that was
destroyed or condemned if any part of the basis of the current home sold
depended on the basis of the destroyed or condemned home under the
involuntary conversion rules.
No Exclusion for Nonqualified Use After 2008
Even if the two-out-of-five-year test for an exclusion is met, gain
attributable to “nonqualified” use after 2008 is not eligible for the
exclusion. The primary intent of the rule is apparently to deny an exclusion
for some of the gain realized by taxpayers who convert a vacation home or
rented residence to their principal residence and live in it for a few years
before selling. However, the law as written is broader, generally treating
any period after 2008 in which the home is not used as a principal residence
by you, your spouse, or former spouse as “nonqualified use.” Despite the
broad wording of the law, there are exceptions ( below) that lessen the
potential impact of the nonqualified use rule. In particular, exception 1
allows many home sellers to avoid nonqualified use treatment where they move
out and rent the home before selling it.
Exceptions to nonqualified use. There are exceptions that limit the impact
of the nonqualified use rule. The law specifically exempts the following
from the definition of post-2008 “nonqualified use”: (1) the period after
you, or your spouse, last use the home as your principal residence, so long
as it is within the five years ending on the date of sale; see Example 2
below, (2) temporary absences from the residence, not to exceed two years in
total, due to a change in employment, health reasons (such as time in a
hospital or nursing home), or other unforeseen circumstances to be specified
by the IRS, and (3) periods of up to 10 years (in aggregate) during which
you, or your spouse, are on qualified official extended duty (duty station
at least 50 miles from residence) as a member of the uniformed services, as
a Foreign Service officer, or as an employee of the intelligence community.
The IRS has not released formal guidelines on “nonqualified use,” including
any other possible exceptions, such as whether short-term rental periods
will be disregarded. However, in Publication 523 it takes the position that
where rental or business space is physically part of the living area of your
home, such as a home office or a spare bedroom that you rent out as part of
a bed-and-breakfast business, that use is treated as residential use.
Although the IRS does not specifically say so, such home office or rental
space within the home is apparently not considered “nonqualified use” in
applying the fractional computation below.
Figuring the excludable and nonexcludable gain. To figure the exclusion on a
sale where there is nonqualified use after 2008, the gain equal to post–May
6, 1997 depreciation (allowed or allowable) is taken into account
first. No exclusion is allowed for this depreciation amount; this is
a long-standing rule that is not changed by the nonqualified use
calculation.
After taking into account post-May 6, 1997 depreciation, the portion of the
remaining gain that is allocable to nonqualified use must be figured; this
amount also is not eligible for the exclusion. The allocation is made by
multiplying the gain by the following fraction:
You can use Worksheet 29-3 later in this chapter to make the allocation and
figure your excludable and taxable gain.
EXAMPLES
1.
Martin bought his home on April 23, 2011, and lived in it until June 30,
2013 when he moved out. He rented the home from July 1, 2013, to June 30,
2015, and claimed depreciation deductions of $10,000 for that period. Martin
moved back into the house July 1, 2015, and lived there until he sold it on
January 31, 2017, for a gain of $310,000. In the five-year period ending on
the date of sale (February 1, 2012 – January 31, 2017), Martin met the
ownership and use test for an exclusion: he owned the home and used it for
more than two years in the five-year period. He owned it for the entire five
years and used it as his home for 36 months (17 months from February 1,
2012–June 30, 2013, and 19 months from July 1, 2015–January 31, 2017), while
renting it for the other 24 months (July 1, 2013–June 30, 2015). The rental
period is nonqualified use.
Using the Gain/loss worksheet, Martin figures his exclusion and taxable gain. The
$10,000 of gain allocable to depreciation cannot be excluded. Of the
remaining $300,000 gain ($310,000 gain -$10,000 depreciation), Martin
figures that $103,800 is allocable to nonqualified use and thus not eligible
for an exclusion. Martin owned the home for 2,110 days (beginning with April
24, 2011, the day after he bought it, and ending on January 31, 2017, the
date of sale). Of his 2,110 ownership days, 730 days (the rental days, July
1, 2013 through June 30, 2015) were nonqualified use. The allocation to
nonqualified use is 730/ 2,110, or 34.6%, and 34.6% x $300,000 is $103,800.
Martin may exclude $196,200 of the gain from income ($300,000-$103,800).
On Form 8949 and Schedule D, Martin will report taxable gain of
$113,800 ($10,000 gain allocable to depreciation + $103,800 gain allocable
to nonqualified use), and also will report the exclusion of $196,200. The
$10,000 gain from depreciation is unrecaptured Section 1250 gain, which
Martin will enter on the Unrecaptured Section 1250 Gain Worksheet in the
Schedule D instructions.
Keep in mind that even without the nonqualified use rule, only $250,000 of
Martin’s $300,000 gain (after depreciation is recaptured) would have been
excludable. The effect of the nonqualified use rule under these facts is to
increase the taxed (nonexcludable) gain by an additional $53,800, from
$50,000 ($300,000 – $250,000) to $103,800 under the allocation formula.
2.
Andrea owned and lived in her principal residence from 2011 through 2014 and
then moved to another state. She rented the home from January 1, 2015, until
April 30, 2017, when she sold it. Andrea met the ownership and use test: she
owned and lived in the house for more than two years in the five-year period
ending on the date of sale (May 1, 2012 – April 30, 2017). Although Andrea
rented out the home after 2008, the rental period (January 1, 2015 – April
30, 2017) is not considered nonqualified use because it was after she moved
out of the home and was within the five-year period ending on the sale date
(Exception 1 under “Exceptions to nonqualified use” on the previous page).
Andrea may exclude gain of up to $250,000, but not gain equal to the
depreciation she claimed (or could have claimed) while the house was rented.
Because the property was rented at the time of sale, the IRS requires the
sale to be reported and the exclusion claimed on form 4797.
Home Sales by Married Persons
Where a married couple owned and lived in their principal residence for at
least two years during the five-year period ending on the date of sale, they
may claim an exclusion of up to $500,000 of gain on a joint return. Under
the law, the up-to-$500,000 exclusion may be claimed on a joint return
provided that during the five-year period ending on the date of sale: (1)
either spouse owned the residence for at least two years, (2) both spouses
lived in the house as their principal residence for at least two years, and
(3) neither spouse is ineligible to claim the exclusion because an exclusion
was previously claimed on a sale of a principal residence within the
two-year period ending on the date of this sale. If Tests 1 and 3 are met
but only one of you meets Test 2, your exclusion limit on a joint return is
$250,000. However, even if the two-out-of-five-year use test is met,
“nonqualified use” after 2008 may limit the exclusion you can claim.
Caution
Exclusion for Married Couple
For a recently married couple, the exclusion limit on a joint return is
$250,000, not $500,000, where one of the spouses has satisfied both the
ownership test and the use test before a sale and the other spouse has not
met the use test. Gain in excess of the $250,000 exclusion is reported on
Form 8949.
Death of spouse before sale. If your spouse died and you inherit the house
and later sell it, you are considered to have owned and used the property
during any period of time when your spouse owned and used it as a principal
home, provided you did not remarry before your sale. This rule can enable
you to satisfy the two-out-of-five-year ownership and use tests where your
spouse met the tests but you on your own did not. It may also enable you to
claim the $500,000 exclusion if you sell the house in the year your spouse
died or within the next two years, as discussed in the next two paragraphs.
If you and your spouse each met the use test and at least one of you met the
ownership test as of the date of your spouse’s death, and you sell the
residence in the year he or she dies, you may use the $500,000 exclusion
limit, assuming you file a joint return for the year of your spouse’s death
and neither of you claimed the exclusion for another home sale in the two
years before your spouse died.
You are also entitled to use the $500,000 exclusion limit on a sale that is
within two years of your spouse’s death, provided you have not remarried and
you and your spouse would have qualified for the $500,000 limit on a sale
immediately before his or her death.
EXAMPLES
1.
You and your spouse owned and occupied your principal residence for 20
years. In December 2017, you sell the house for a gain of $450,000. If you
file jointly, none of the gain is taxable as the up-to-$500,000 exclusion
applies.
2.
After your spouse died, you owned and lived in your principal residence from
June 2012 through the end of 2016. In January 2017 you remarried and you and
your wife lived in the house for nine months. In October 2017, you sold the
house and realized a gain of $350,000. On a joint return for 2017, you may
claim an exclusion of $250,000; the balance of $100,000 is taxable. You meet
the exclusion tests, but your wife does not. Thus, the exclusion is limited
to $250,000.
Divorce. If a residence is transferred to you incident to divorce, the time
during which your former spouse owned the residence is added to your period
of ownership. If pursuant to a divorce or separation decree or agreement you
move out of a home that you own or jointly own with your spouse or former
spouse, you are treated as having used the home for any period that you
retain an ownership interest in the residence while the other spouse or
former spouse continues to use it as a principal residence under the terms
of the divorce or separation agreement.
Separate residences. Where a husband and wife own and live in separate
residences, each spouse is entitled to a separate exclusion limit of
$250,000 on the sale of his or her residence. If both residences are sold in
the same year and each spouse met the ownership and use test for his or her
separate residence, two exclusions may be claimed (up to $250,000 each),
either on a joint return or on separate returns.
Reduced Maximum Exclusion
Generally, no exclusion is allowed on a sale of a principal residence if you
owned or used the home for less than two of the five years preceding the
sale. Similarly, an exclusion is generally disallowed if within the
two-year period ending on the date of sale, you sold another home at a gain
that was wholly or partially excluded from your income.
However, even if a sale of a principal residence is made before meeting the
ownership and use tests or it is within two years of a prior sale for which
an exclusion was claimed, a partial exclusion is available if the primary
reason for the sale is: (1) a change in the place of employment, (2) health,
or (3) unforeseen circumstances. If the sale is for one of these qualifying
reasons, you are entitled to a prorated portion of the regular $250,000 or
$500,000 exclusion limit. The employment change, health problem, or
unforeseen circumstance can be attributable to you or another “qualified
individual,” as defined below.
You automatically qualify for the reduced exclusion if your sale is within a
safe harbor established by the IRS. If a safe harbor is not available, you
may qualify by showing that the “facts and circumstances” of your situation
establish that the primary reason for the sale was a change in the place of
employment, health problem or unforeseen circumstances.
When you fall within a safe harbor or meet the primary reason test, you are
allowed an allocable percentage of the regular $250,000 or $500,000
exclusion limit, depending on how much of the regular two-year ownership and
use test was satisfied, or the time between this sale and a sale within the
prior two years. For example, if you owned and lived in your home for 438
days before selling it to take a new job, you are entitled to 60% of the
regular exclusion limit, which is based on 730 qualifying days (438/730 =
60%). Use the Reduced maximum exclusion worksheet to figure your reduced exclusion limit. Although
the maximum exclusion is reduced, this may not disadvantage you. If the
reduced exclusion limit equals or exceeds your gain, none of your gain is
subject to tax.
IRS Alert
Amended Return to Claim Reduced Maximum Exclusion
If you reported gain on a sale that can be avoided under the reduced maximum
exclusion rules for sales due to a change in place of employment, health, or
unforeseen circumstances, a refund claim can be made on an amended return,
provided the prior year is not closed by the statute of limitations.
Qualified individual. In addition to yourself, the following persons are
considered qualified individuals for purposes of qualifying for the reduced
maximum exclusion: your spouse, a co-owner of the residence, or any person
whose main home was your principal residence.
For purposes of the “health reasons” category, qualified individuals include
not only the above individuals but also their family members: parents or
step-parents, grandparents, children, stepchildren, adopted children,
grandchildren, siblings (including step- or half-siblings), in-laws
(mother/father, brother/sister, son/daughter), uncles, aunts, nephews, or
nieces.
EXAMPLE
You bought and moved into your residence on April 4, 2017, so your holding
period begins on April 5, 2017. In 2018 you move to a new job location in
another state and sell your house at a gain of $50,000 on April 4, 2018.
Since you owned and used your home for 12 months (365 days), your exclusion
limit is reduced by 50% (365/730 days). You are single. Your reduced
exclusion limit is $125,000 (50% of $250,000) and since the gain of $50,000
is totally covered by the $125,000 exclusion it is not taxable.
Sale due to change in place of employment. The reduced exclusion limit
applies if the primary reason for your sale is a change in the location of a
qualified individual’s employment; see the above definition of qualified
individual. “Employment” includes working for the same employer at a
different location or starting with a new employer. It also includes the
commencement of self-employment or the continuation of self-employment at a
new location.
The IRS provides a safe harbor based on distance. If a qualified
individual’s new place of employment is at least 50 miles farther from the
sold home than the old place of employment was, the reduced exclusion limit
is allowed so long as the change in employment occurred while you owned and
used the home as your principal residence. If an unemployed qualified person
obtains employment, the safe harbor applies if the sold home is at least 50
miles from the place of employment.
If the 50-mile safe harbor cannot be met, the facts and circumstances may
indicate that a change in the place of employment was the primary reason for
the sale, thereby allowing the reduced exclusion limit.
EXAMPLE
An emergency room physician buys a condominium in March 2017 that is five
miles from the hospital where she works. In November 2017, she takes a new
job at a hospital 51 miles away from her home. She sells her home in
December 2017 and buys a townhouse that is four miles away from the new
hospital. The sale does not qualify for the 50-mile safe harbor since the
new hospital is only 46 miles further from the old home than the first
hospital was. However, given the doctor’s need to work unscheduled hours and
to get to work quickly, the IRS allows the reduced exclusion limit; the
facts show that her change in place of employment was the primary reason for
the home sale.
Sale due to health problems. The reduced exclusion limit applies if a
principal residence is sold primarily to obtain or facilitate the diagnosis,
treatment, or mitigation of a qualified person’s disease, illness or injury,
or to obtain or provide medical or personal care for a qualified individual
suffering from a disease, illness, or injury. A sale does not qualify if it
is merely to improve general health. Note that for “health sales,” the
definition of qualified individual is broadened to include family members;
see above.
A physician’s recommendation of a change in residence for health reasons
automatically qualifies under an IRS safe harbor.
EXAMPLES
1.
One year after purchasing a home in Michigan, Smith is told by his doctor
that moving to a warm, dry climate would mitigate his chronic asthma
symptoms. Smith takes the advice, selling the house and moving to Arizona.
The sale is within the doctor recommendation safe harbor and Smith may claim
a reduced maximum exclusion for gain on the sale of the Michigan home.
1.
In 2017, Mike and Kathy Anderson sell the house they bought in 2016 so they
can move in with Kathy’s father, who is chronically ill and unable to care
for himself. The IRS allows the Andersons to claim a reduced maximum
exclusion, as the primary reason for the sale is to provide care for Kathy’s
father, a qualified individual.
Sale due to unforeseen circumstances. A sale of a principal residence due to
any of the following events fits within an IRS safe harbor for unforeseen
circumstances and automatically qualifies for a reduced maximum exclusion:
(1) The involuntary conversion of the home (condemnation or destruction of
house in a storm or fire);
(2) Damage to the residence from a natural or man-made disaster, war, or act
of terrorism;
(3) Any of the following events involving a qualified individual: death, divorce or legal separation, becoming eligible for
unemployment compensation, a change in employment or self-employment status
that left the qualified individual unable to pay housing costs and
reasonable basic household expenses, or multiple births resulting from the
same pregnancy.
The IRS may expand the list of safe harbors in generally applicable revenue
rulings or in private rulings requested by individual taxpayers.
Sales not covered by a safe harbor can qualify if the facts and
circumstances indicate that the home was sold primarily because of an event
that could not have been reasonably anticipated before the residence was
purchased and occupied. The IRS in private letter rulings has been quite
liberal in allowing the reduced maximum exclusion for unforeseen sales; see
the examples below. Even the birth of a second child has been held to be an
unforeseen circumstance (Example 5). However, an improvement in financial
circumstances does not qualify under IRS regulations, even if the
improvement is the result of unforeseen events, such as receiving a
promotion and a large salary increase that would allow the purchase of a
bigger home.
EXAMPLES
1.
Three months after Jones buys a condominium as his principal residence, the
condominium association replaces the roof and heating system and a few
months later the monthly condominium fees are doubled. If Jones sells the
condo because he cannot pay the higher fees and his monthly mortgage
payment, the sale is considered to be due to unforeseen circumstances and
Jones may claim a reduced maximum exclusion.
2.
Tom and his fiancée, Alice, buy a house and live in it as their principal
residence. The next year they break up and Tom moves out. The house is sold
because Alice cannot afford to make the monthly payments alone. According to
the IRS, the sale is due to unforeseen circumstances and Alice and Tom may
each claim a reduced maximum exclusion.
3.
A married couple purchased a home in a retirement community that had minimum
age requirements for residents. Shortly after they moved in, their daughter
lost her job and was in the process of getting a divorce. The daughter and
her child wanted to move in but could not because of the community’s age
requirements. The couple sold the home and bought a new one in which their
daughter and grandchild lived while the daughter looked for full-time
employment. The IRS privately ruled that the sale of the retirement
community home was due to unforeseen circumstances and the reduced maximum
exclusion could be claimed.
4.
A single mother bought a home and lived in it with her two daughters as
their principal residence. One of the daughters was subjected to unruly
behavior, verbal abuse, and sexual assault on the school bus. As a result,
the daughter suffered from persistent fear and her school performance
seriously declined. Her behavior was noticed by the school and brought to
the mother’s attention. She tried to work with the school district to
resolve the problem, but when attempts failed, she sold her home and moved.
The mother had not owned the home for two full years and asked the IRS
whether she qualified for a partial exclusion. The IRS said yes. The primary
reason for the sale prior to satisfying the two-year test was an unforeseen
circumstance—the extreme bullying suffered by her daughter. Therefore, she
can prorate the home sale exclusion for the part of the two years that she
owned and lived in the home.
5.
A married couple with one child bought a condominium with two small bed
rooms and two baths. The child’s bedroom was also used as the husband’s home
office and a guest room. After the wife gave birth to a second child, they
moved out of the condo and later sold it at a gain. The IRS in a private
ruling concluded that the birth of a second child was an unforeseen
circumstance that rendered the condo unsuitable as a residence. Therefore,
the couple could claim the reduced maximum exclusion.
Figuring Gain or Loss
To figure the gain or loss on the sale of your principal residence, you must
determine the selling price, the amount realized, and the adjusted basis.
The Gain/Loss Exclusion and Taxable gain worksheet may be used to figure gain or loss on the sale of a principal
residence.
Filing Tip
Form 1099-S
If you received Form 1099-S, Box 2 should show the gross proceeds from the
sale of your home. However, Box 2 does not include the fair market value of
any property other than cash or notes, or any services you received or will
receive. For these, Box 4 will be checked. If the sales price of your home
does not exceed $250,000 or $500,000 (if filing jointly) and you certify to
the person responsible for closing the sale that your entire gain is
excludable from your gross income, that person does not have to report the
sale on Form 1099-S, but may choose to do so.
Gain or loss. The difference between the amount realized and adjusted basis
is your gain or loss. If the amount realized exceeds the adjusted basis, the
difference is a gain that may be excluded. If amount realized is less than
adjusted basis, the difference is a loss. A loss on the sale of your main
home may not be deducted.
Foreclosure or repossession. If your home was foreclosed on or
repossessed, you have a sale.
Selling price. This is the total amount received for your home. It includes
money, all notes, mortgages, or other debts assumed by the buyer as part of
the sale, and the fair market value of any other property or any services
received. The selling price does not include receipts for personal property
sold with your home. Personal property is property that is not a permanent
part of the home, such as furniture, draperies, and lawn equipment.
If your employer pays you for a loss on the sale or for your selling
expenses, do not include the payment as part of the selling price. Include
the payment as wages on Line 7 of Form 1040. (Your employer includes the
payment with the rest of your wages in Box 1 of your Form W-2.)
If you grant an option to buy your home and the option is exercised, add the
amount received for the option to the selling price of your home. If the
option is not exercised, you report the amount as ordinary income in the
year the option expires. Report the amount on Line 21 of Form 1040.
Amount realized. This is the selling price minus selling expenses, including
commissions, advertising fees, legal fees, and loan charges paid by the
seller (e.g., loan placement fees or “points”).
Adjusted basis. This is the cost basis of your home increased by the cost of
improvements and decreased by deducted casualty losses, if any. Cost
basis is generally what you paid for the residence. If you obtained
possession through other means, such as a gift or inheritance, see the
special basis rules for gifts and inheritances.
Seller-paid points. If the person who sold you your residence paid points on
your loan, you may have to reduce your basis in the home by the amount of
the points. If you bought your residence after 1990 but before April 4,
1994, you reduce basis by the points only if you chose to deduct them as
home mortgage interest in the year paid. If you bought the residence after
April 3, 1994, you reduce basis by the points even if you did not deduct the
points.
Filing Tip
Jointly Owned Home
If you and your spouse sell your jointly owned home and file a joint return,
you figure your gain or loss as one taxpayer. If you file separate returns,
each of you must figure your own gain or loss according to your ownership
interest in the home. Your ownership interest is determined by state law.
If you and a joint owner other than your spouse sell your jointly owned
home, each of you must figure your own gain or loss according to your
ownership interest in the home.
Settlement fees or closing costs. When buying your home, you may have to pay
settlement fees or closing costs in addition to the contract price of the
property. You may include in basis fees and closing costs that are for
buying the home. You may not include in your basis the fees and costs of
getting a mortgage loan. Settlement fees also do not include amounts placed
in escrow for the future payment of items such as taxes and insurance.
Examples of the settlement fees or closing costs that you may include in the
basis of your property are: (1) abstract fees (sometimes called abstract of
title fees), (2) charges for installing utility services, (3) legal fees
(including fees for the title search and preparing the sales contract and
deed), (4) recording fees, (5) survey fees, (6) transfer taxes, (7) owner’s
title insurance, and (8) any amounts the seller owes that you agree to pay,
such as certain real estate taxes, back interest, recording or mortgage
fees, charges for improvements or repairs, and sales commissions.
Examples of settlement fees and closing costs not included in your basis
are: (1) fire insurance premiums, (2) rent for occupancy of the home before
closing, (3) charges for utilities or other services relating to occupancy
of the home before closing, (4) any fee or cost that you deducted as a
moving expense before 1994, (5) charges connected with getting a mortgage
loan, such as mortgage insurance premiums (including VA funding fees), loan
assumption fees, cost of a credit report, and fee for an appraisal required
by a lender, and (6) fees for refinancing a mortgage.
Construction. If you contracted to have your residence built on land you
own, your basis is the cost of the land plus the cost of building the home,
including the cost of labor and materials, payments to a contractor,
architect’s fees, building permit charges, utility meter and connection
charges, and legal fees directly connected with building the home.
Caution
Repairs
These maintain your home in good condition but do not add to its value or
prolong its life. You do not add their cost to the basis of your property.
Examples of repairs include repainting your house inside or outside, fixing
gutters or floors, repairing leaks or plastering, and replacing broken
window panes. However, repairs made as part of a larger remodeling or
restoration project are treated by the IRS as capital improvements that
increase basis.
Cooperative apartment. Your basis in the apartment is usually the cost of
your stock in the co-op housing corporation, which may include your share of
a mortgage on the apartment building.
Figuring Adjusted Basis
Adjusted basis in your home is cost basis adjusted for items. The Adjusted
Basis of Home Sold Worksheet may be used to figure adjusted basis.
Increases to cost basis include: improvements with a useful life of more
than one year, special assessments for local improvements, and amounts spent
after a casualty to restore damaged property.
Decreases to cost basis include: gain you postponed from the sale of a
previous home before May 7, 1997, deductible casualty losses not covered by
insurance, insurance payments you received or expect to receive for casualty
losses, itemized deductions claimed for general sales taxes on the purchase
of a houseboat or a mobile home, payments you received for granting an
easement or right-of-way, depreciation allowed or allowable if you used your
home for business or rental purposes, any allowable tax credit after 2005
for a home energy improvement that increases the basis of the home,
residential energy credit (generally allowed from 1977 through 1987) claimed
for the cost of energy improvements added to the basis of your home,
adoption credit you claimed for improvements added to the basis of your
home, nontaxable payments from an adoption assistance program of your
employer that you used for improvements added to the basis of your home,
District of Columbia first-time homebuyers credit (allowed to qualifying
first-time homebuyers for purchase after August 4, 1997 and before 2012 ),
and an energy conservation subsidy excluded from your gross income because
you received it (directly or indirectly) from a public utility after 1992 to
buy or install any energy conservation measure. An energy conservation
measure is an installation or modification that is primarily designed either
to reduce consumption of electricity or natural gas or to improve the
management of energy demand for a home.
Planning Reminder
Gains Postponed Under Prior Law Rules
Gain on a previous home sale that you postponed under the prior law rollover
rules reduces the basis of your current home if your current home was a
qualifying replacement residence for the previous home. Postponed gains on
several earlier sales may have to be taken into account under the basis
reduction rule. The basis reduction will increase the gain on the sale of
your current home.
Improvements. Improvements add to the value of your home, prolong its useful
life, or adapt it to new uses. You add the cost of improvements to the basis
of your property.
Examples of improvements include: bedroom, bathroom, deck, garage, porch,
and patio additions, landscaping, paving driveway, walkway, fencing,
retaining wall, sprinkler system, swimming pool, storm windows and doors,
new roof, wiring upgrades, satellite dish, security system, heating system,
central air conditioning, furnace, duct work, central humidifier, filtration
system, septic system, water heater, soft water system, built-in appliances,
kitchen modernization, flooring, wall-to-wall carpeting, attic, walls, and
pipes.
Adjusted basis does not include the cost of any improvements that are no
longer part of the home.
EXAMPLE
You installed wall-to-wall carpeting in your home 15 years ago. In 2017, you
replace that carpeting with new wall-to-wall carpeting. The cost of the new
carpeting increases your basis, but the cost of the old carpeting is no
longer part of adjusted basis.
Recordkeeping. Ordinarily, you must keep records for three years after the
due date for filing your return for the tax year in which you sold your
home. But you should keep home records as long as they are needed for tax
purposes to prove adjusted basis. These include: (1) proof of the home’s
purchase price and purchase expenses, (2) receipts and other records for all
improvements, additions, and other items that affect the home’s adjusted
basis, (3) any worksheets you used to figure the adjusted basis of the home
you sold, the gain or loss on the sale, the exclusion, and the taxable gain,
and (4) any Form 2119 that you filed to postpone gain from a home sale
before May 7, 1997.
Personal and Business Use of a Home
If in 2017 you sold a home that was used for business or rental as well as
residential purposes, you may be able to exclude part or all of any gain
realized on the sale. The excludable amount depends on whether the
non-residential and residential areas were part of the same dwelling unit,
whether the ownership and use tests were met, whether depreciation
was allowable after May 6, 1997, and whether the non-residential use was
before 2009 or after 2008.
Nonqualified use after 2008. Gain allocable to periods of “nonqualified” use
(not used as principal residence) after 2008 is not excludable from income, but certain nonresidential periods are excluded from the definition
of nonqualified use. For example, renting your home after you (and your
spouse) move out is not nonqualified use if the rental occurs within the
five-year period ending on the date of sale.
Law Alert
Nonqualified Use After 2008 May Limit Exclusion
Unless an exception applies, any period after 2008 that a home is not
used as your principal residence is considered a period of “nonqualified
use,” and gain allocable to the nonqualified use is taxable, even if the
two-year residential use test for an exclusion is otherwise met.
The IRS does not treat home office use or rental of a spare room after 2008
as nonqualified use.
Home office or rental space within your principal residence. The IRS takes
the position that gain does not have to be allocated between the residential
and business use portions of your home where both are within the same
dwelling unit. This rule allows a home office to be considered part of your
residential property for purposes of the home sale exclusion. Similarly, the
IRS considers renting a spare room as a bed-and-breakfast bedroom to be
residential use. If the two-out-of-five-year ownership and use test
is met for the regular residential portion, you are also treated as meeting
the two-year residential use test for the home office or rental space, even
if you used the area as a business office or rented room for your entire
period of ownership. As a result, the gain on the entire residence is
eligible for the exclusion, except for the gain equal to depreciation for
periods after May 6, 1997. The gain equal to post–May 6, 1997, depreciation
is never excludable; it must be reported on Schedule D (Form 1040) as unrecaptured Section 1250 gain.
EXAMPLE
Alice bought a house in March 2011 that she lived in as her principal
residence. She used one room as a law office from May 2013 until September
2016, and claimed depreciation deductions of $2,500 for the office space
during that period. She sells the home in 2017. Assume that gain on the sale
is $24,000. Since the office and residential area were in the same dwelling
unit, Alice does not have to allocate gain to the office. Since she meets
the ownership and use tests for the residential part, the tests are also
considered met for the office space, She may exclude $21,500 of the $24,000
gain from her 2017 income. The $2,500 of gain equal to depreciation cannot
be excluded. Alice reports her $24,000 gain and the $21,500 exclusion in
Part II of Form 8949. The $2,500 gain attributable to the depreciation
is unrecaptured Section 1250 gain, which Alice enters on the Unrecaptured
Section 1250 Gain Worksheet in the Schedule D instructions.
Depreciation allowed or allowable. Under IRS rules, you must reduce your
basis in the home for purposes of figuring gain on a sale by any
depreciation you were entitled to deduct, even if you did not deduct it.
Furthermore, you cannot exclude the gain equal to the depreciation allowed
or allowable for periods after May 6, 1997. This means that if you were
entitled to take depreciation deductions for periods after May 6, 1997, but
did not do so, the gain equal to the allowable depreciation is generally not
excludable. However, if you have records showing that you claimed less
depreciation than was allowable, the IRS will reduce the excludable gain
only by the claimed (allowed) depreciation.
Business or rental area separate from your dwelling unit. If you sell
property that was partly your home and partly business or rental property
separate from your dwelling unit, and the business/rental use of the
separate part exceeded three years during the five years before the sale,
the gain allocable to the separate part is not eligible for an exclusion
(since the two-year use test has not been met for that part) and must be
reported as taxable income on Form 4797. This could be the case if you lived
in one apartment and rented out other apartments in the same building, you
rented out an unattached garage or building elsewhere on your property, your
apartment was upstairs from your business, you operated a business from a
barn or other structure separate from your business, or your home was
located on a working farm.
No Loss Allowed on Personal Residence
A loss on the sale of your principal residence is not deductible. You do not
have to report the sale on your return unless you received a Form 1099-S. If
you received Form 1099-S, you must report the sale on Form 8949 even
though the loss is not deductible. Code “L” must be entered in column (f) of
Form 8949 to indicate that the loss is not deductible, and the nondeductible
loss must be entered as a positive adjustment in column (g). These are the
same reporting rules as for a second home or vacation home discussed below.
If part of your principal residence was used for business in the year of
sale, treat the sale as if two pieces of property were sold. Report the
personal part on Form 8949 and the business part on Form 4797. A loss is
deductible only on the business part.
Second home or vacation home. If you sell at a loss a second home or
vacation home that was used entirely for personal purposes and the sale was
reported on Form 1099-S, you report the sale on Form 8949 and Schedule D,
even though the loss is not deductible. On Form 8949, report the
proceeds in column (d) and your basis in column (e). The loss (excess of
basis over proceeds) is not deductible, so code “L” must be entered in
column (f) and the amount of the loss entered as a positive amount in column
(g). The positive adjustment in column (g) negates the loss, so the gain or
loss in column (h) will be “0”. If in the year of sale part of the
home was rented out or used for business, allocate the sale between the
personal part and the rental or business part; report the personal part on
Form 8949 and the rental or business part on Form 4797.
Loss on Residence Converted to Rental Property
You are not allowed to deduct a loss on the sale of your personal residence.
If you convert the house from personal use to rental use you may claim a
loss on a sale if the value has declined below the basis fixed for the
residence as rental property.
Filing Tip
Loss Allowed
If you sell a house that has been converted from personal to rental use, and
the sales price is less than the conversion date basis, a loss on the sale
is deductible.
To determine if you have a loss for tax purposes, you need to know the
conversion date basis. This is the lower of (1) your adjusted basis
for the house at the time of conversion or (2) the fair market value at the
time of conversion. Add to the lower amount the cost of capital improvements
made after the conversion, and subtract depreciation and casualty loss
deductions claimed after the conversion. To deduct a loss, you have to be
able to show that this basis exceeds the sales price. For example, if you
paid $200,000 for your home and convert it to rental property when the value
has declined to $150,000, your conversion date basis for the rental property
is $150,000. If the property continues to decline in value, and you sell for
$125,000 after having deducted $10,000 for depreciation, you may claim a
loss of $15,000 ($140,000 (conversion date basis of $150,000 reduced by
$10,000 depreciation) – $125,000 sales price). Your loss deduction will not
reflect the $50,000 loss occurring before the conversion.
Caution
Temporary Rental Before Sale
A rental loss may be barred on a temporary rental before sale. The IRS and
Tax Court held that where a principal residence was rented for several
months while being offered for sale, the rental did not convert the home to
rental property. Deductions for rental expenses were limited to rental
income; no loss could be claimed. A federal appeals court disagreed and
allowed a rental loss deduction.
EXAMPLE
In 1988, Adams bought a house in Fort Worth, Texas. He paid $124,000, put in
capital improvements, and lived there until he was forced to put it on the
market when he lost his job. In 1989, he listed the house with a broker for
$145,000. After receiving no offers, he decided to lease the house through
1990. By October of 1990 Adams owed $4,551 in property taxes and was three
months behind on his mortgage payments. Fearing foreclosure, he sold the
house for $130,000.
For purposes of figuring a loss, Adams assumed that the fair market value at
the time of conversion was equal to the $145,000 list price. The adjusted
basis of the house was $141,026. As this was less than the estimated fair
market value of $145,000, he used the $141,026 adjusted basis to figure a
loss of $11,026 ($130,000 – $141,026). The IRS claimed the fair market value
at the time of conversion was equal to the actual sale price of $130,000.
Since basis for the converted property is the lesser of fair market value
($130,000) or adjusted basis ($141,026), Adams had no loss on the sale.
However, the Tax Court allowed a $5,000 loss by fixing the fair market value
at the time of conversion at $135,000. It held that Adams sold at a lower
price because of his weak financial position of which the buyer took
advantage. The court figured the $135,000 as follows: $129,000 fair market
value in 1988 (based on an appraisal report, which both parties agree was
correct), plus $6,000 of appreciation attributable to the capital
improvements made to the property after it was converted.
Partially rented home. If you rented part of your home for over three years
during the five years preceding the sale, you must allocate the basis and
amount realized between the portion used as your home and the rented portion. A loss on a sale is allowable on the rented portion, which is
reported on Form 4797.
Profit-making purposes. Renting a residence is a changeover from personal to
profit-making purposes. If a house is merely put up for rent such as by
listing it with a realty company but little else is done to obtain tenants
and the property is in fact not rented, the IRS is likely to conclude that
it was not converted to property held for the production of income and a
loss on the sale will be treated as a nondeductible personal loss.
Similarly, where a house is only rented for several months prior to a sale,
the IRS may not treat this as a conversion to rental property and may
disallow a loss deduction claimed on the sale.
Loss allowed on house bought for resale. A loss deduction may also be
allowed where you acquired the house as an investment with the intention of
selling it at a profit, even though you occupied it incidentally as a
residence prior to sale. In an unusual case, an owner bought a house with
the intention of selling it. He lived in it for six years, but during that
period it was for sale. The Tax Court allowed him to deduct the loss on its
sale by proving he lived in it to protect it from vandalism and to keep it
in good condition so that it would attract possible buyers.
In another case, an architect and builder built a house and offered it for
sale through an agent and advertisements. He had a home and no intention to
occupy the new house. On a realtor’s advice, he moved into the house to make
it more saleable. Ten months later, he sold the house at a loss of $4,065
and promptly moved out. The loss was allowed on proof that his main purpose
in building and occupying the house was to realize a profit by a sale; the
residential use was incidental.
Gain on rented residence. You have a gain on the sale of rental property if
you sell for more than your adjusted basis at the time of conversion, plus
subsequent capital improvements, and minus depreciation and casualty loss
deductions. The sale is subject to the rules for depreciable
property.
Loss on Residence Acquired by Gift or Inheritance
You may deduct a loss on the sale of a house received as an inheritance or
gift if you personally did not use it and offered it for sale or rental
immediately or within a few weeks after acquisition.
Planning Reminder
Inherited Residence
If you inherit a residence in which you do not intend to live, it may be
advisable to put it up for rent to allow for an ordinary loss deduction on a
later sale. If you merely try to sell, and you finally do so at a loss, you
are limited to a capital loss.
EXAMPLES
1.
A couple owned a winter vacation home in Florida. When the husband died, his
wife immediately put the house up for sale and never lived in it. It was
sold at a loss. The IRS disallowed her capital loss deduction, claiming it
was personal and nondeductible. The wife argued that her case was no
different from the case of an heir inheriting and selling a home, since at
the death of her husband her interest in the property was increased. The Tax
Court agreed with her reasoning and allowed the capital loss deduction.
2.
A widow inherited a house owned by her late husband and rented out by his
estate. Shortly after getting title to the house, she sold it at a loss that
she deducted as an ordinary loss. The IRS limited her to a capital loss
deduction. The Tax Court agreed. She could not show any business activity.
She did not negotiate the lease with the tenant who was in the house when
she received title. She never arranged any maintenance or repairs for the
building. Moreover, she sold the property shortly after receiving title,
which indicates she viewed the house as investment, not rental, property.
3.
An inherited residence was rented out by the owner to her brother for $500 a
month when the fair market rental value was $700 to $750 per month. When she
sold the residence at a loss, the IRS disallowed the loss, and the Tax Court
agreed. The below-market rental was treated as evidence that she held the
property for personal purposes, not as rental property or as investment
property held for appreciation in value.
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